Here we look at how different pensions schemes work, what changes the government is proposing and who will be affected.

What is a defined benefit pension?

Defined-benefit schemes are the gold standard of pensions. They became popular after the second world war and were the norm at big British corporations such as British Telecom and Vauxhall.

Employers pay benefits that are linked to your salary, so your income in retirement automatically increases as your pay rises. Your employer contributes to the scheme and is responsible for ensuring there is enough money at the time you retire to pay your pension. Your pension entitlement is not dependent on the performance of the stock market or other investments, and the scheme must increase your pension income each year in line with inflation.

There are also additional benefits such as survivors’ rights, which pay an income to widows and widowers and civil partners. Members can start taking a pension when they reach their scheme’s pension age, set out in each scheme’s rules. These schemes are run by trustees who look after the interests of the scheme’s members. DB schemes are protected by the Pension Protection Fund, which pays compensation to scheme members if their employer goes bust or the scheme doesn’t have enough money to pay members’ benefits.

Is that the same as final salary?

There are two main types of DB schemes - final salary and career average.

In final salary schemes, your pension is based on the salary you earn in the years immediately before you retire. If you have a final salary scheme with a previous employer, your income will be based on your salary in the years before you left the company. Career average schemes are less generous - they calculate your pension based on your average earnings during the time you were an active member in a scheme.

And what is a defined contribution scheme?

The vast majority of workers in Britain will have a defined contribution pension scheme. Employees save into a fund alongside contributions from their employer and this money is invested mainly in stocks and shares. Unlike DB schemes, there is no promise of a specific income in retirement – the size of your pension will depend on how much you pay into the scheme and how well your chosen investments perform. When you retire you can take some of your pension as a cash lump sum and use the rest to buy an annuity.

What exactly is being proposed?

The Government wants to introduce “defined ambition” pensions in the private sector, which would be a half-way house between DB and DC schemes. This would ensure risk is spread more evenly across employers and employees. Under this banner, it is considering three main options – new flexible defined benefit schemes, adding guarantees to existing defined contribution schemes and introducing a new type of pension called collective defined contribution schemes.

• Flexible DB schemes would be stripped down so that there is no requirement to increase pensions in line with inflation or to pay benefits to survivors. Pensions would be linked to salary so members would have more certainty around their retirement income than those in DC schemes, however employers could increase the scheme pension age to reflect increasing life expectancy.

Employers could choose to provide discretionary benefits to members, such as indexation or one-off bonus payments, in years when the pension scheme has performed well. Flexible DB schemes could also choose to move members into a DC scheme if they leave a company. The amount of pension benefit they have accrued in the scheme would be crystallised and the cash value transferred to DC pension fund.

• Guarantees for DC schemes would mean workers do not have to shoulder all the risk. The Government has proposed a number of options including a “money-back” guarantee, which would prevent the value of a member’s pot from falling below the level of contributions made to the scheme, and capital and investment return guarantees that would protect the value of a member’s pot once it reaches a certain size.

• Collective defined contribution schemes, common in the Netherlands, pool members’ contributions and pensions would be paid from the collective fund. Members would not need to buy an annuity and employers would not need to take on any liability for the scheme.

Why does the Government want to do this?

Defined benefit schemes are becoming increasingly rare in the private sector as rising lifespans make it ever more expensive for companies to honour their promises to retiring workers. Official figures show that the number of private sector workers still part of such schemes fell from 3 million in 2006 to just 1.7 million today.

Most of the surviving schemes have also closed their doors to new members: 85 per cent have stopped accepting new employees since 2000. The Government said it wants to encourage large companies – those with more than 500 employees – to offer more generous pensions than defined contribution schemes by continuing to link income to salaries.

Is it bad news for existing defined benefit scheme members?

All money already built up in a DB scheme would be protected from the changes, but if an employer switched to a flexible DB scheme any further money saved would be affected.

Scrapping indexation so pensions no longer increase in line with inflation could cut the real value of a pension income by almost a third over a 15-year retirement. For example, a £20,000 pension income today would be worth just £13,411 in 2028 if inflation continues at its current level of 2.7pc.

Workers could also lose income if their company increased the retirement age and benefits such as survivors’ rights are lost. Members of public sector DB schemes will not be affected.

Who stands to benefit the most?

Employees of large companies whose employer decides to switch from a defined contribution scheme to a flexible defined benefit scheme. These workers would see their retirement income tied to their salary so their pension would not be dependent on how well their investments fared on the stock market.

Would it mean companies contribute more?

Whether an employer increased its contribution above statutory minimums would be a decision for individual companies to take, but the Government said these changes would appeal to companies that want to offer their workers a quality pension scheme. It is hoped that these companies will be more generous with their pension contributions.

Where do annuities come into all of this?

Some of these new defined ambition schemes could be set up so that the scheme pays retirement income directly to members. This means members would not need to buy an annuity when they retire. Only employees whose company signs up to a defined ambition scheme would have this option.

What happens next in this process?

The consultation will run until December 19 and individuals and companies can respond formally to the proposals. The Government will then publish a report summarising the responses it received and the action it will take as a result. Mr Webb said if the feedback is positive, he will look to make the necessary legislative changes during this parliament, which ends in May 2015.